Why It Will Fail
Part I – The State of Healthcare
By Jay Mathur, CEO valueideas
On January 30, 2018, these titans of industry representing Amazon, Berkshire Hathaway and J.P. Morgan announced a joint venture (my acronym, “ABJ Venture”), with little fanfare and even fewer details, to take on the challenge of healthcare in the U.S. They proclaimed that the venture would be “free from profit-making incentives”. In the press release Mr. Buffett famously called the healthcare as “ a hungry tapeworm on the American economy”.
Since that brief announcement, Mr. Buffett, in a CNBC interview on February 26, 20181, suggested that the goal of the ABJ Venture is to figure out how to stop healthcare from consuming bigger part of the US economy and lower the cost of healthcare.
Mr. Dimon in his annual letter to the shareholder on April 5, 20182 gave more details. He outlined areas of focus such as aligning incentives among doctors, insurers and patients; reducing fraud and waste; giving employees more access to telemedicine and better wellness programs; determining why costly and specialized drugs are under or over utilized; and figuring out why so much money is spent on end-of-life care. Mr. Dimon added, “We will be using top management, big data, virtual technology, better customer engagement and the improved creation of customer choice”. He stated that the effort would start small and he would share more in the “coming years”, implying a longer-term effort.
Highly anticipated annual shareholder letter from Mr. Bezos released on April 19, 2018, made no mention of the ABJ Venture.
Why is ABJ Venture important?
To understand it, all you have to do is to look at the major sponsors3 of funding for the US healthcare. The largest sponsors are the federal government (28%) and households (28%), followed by private employers (20%) and state and local governments (17%).
Government may be a logical choice to take on the healthcare issues, but given our divisions at the political and policy levels, especially in healthcare, it is effectively paralyzed. Households/Consumers as a group are not organized to take on a sustained effort to address the healthcare challenges.
That makes employers as the pre-eminent players. They have the vested interest in the healthiness of their employees to improve productivity, innovation, competitiveness and profits. They have the clout to influence policy and politics and drag politicians and the governments into this effort.
Previously, there were efforts by individual employers as well as some collections of them, but they mostly ended up using their leverage to save a few dollars for themselves but otherwise were ineffective.
Given the stature and the respect that Messrs. Bezos, Buffett and Dimon command, deep pockets and talent pools at their disposal, combined with the stated objective of taking a long view and avoiding profit constraints, makes ABJ Venture a rare opportunity to take on the challenges of healthcare.
It would be instructive to look at the state of the industry that this venture would take on.
What is the state of the healthcare industry?
According to the Center for Medicare and Medicaid Services (CMS) 3, it is estimated that the U.S. national healthcare expenditure (NHE) to be about $3.5 trillion in 2017. Over the next ten years, the average annual growth rate is estimated to be 5.5% with the projected NHE of $5.7 trillion by 2026. The cost is growing faster than the GDP, revenues and incomes of the key payers such as governments, employers and households respectively.
Numerous studies and reports suggest the wasteful spending in the industry to be wide-ranging, but most agree that it is at least 30% of the cost. This includes waste of the critical resources in what can be characterized as misuse, such as popular services that do nothing to improve outcomes, abuse, such as fraudulent billings and services, and overuse such as over consumption of drugs and services; as well as the good old red tape churned out by regulators and administrators.
Using Mr. Buffett’s analogy, healthcare is a giant and growing tapeworm that devours critical resources and wastes over $1 trillion annually.
To understand the enormity of the waste in the healthcare system, let’s look at a sliver of it. Medicare stated that in 2017 it lost $60 billion to fraud (such as billing for phantom patients or services) or about 10% of its budget. In an interview to the AARP Bulletin, the Attorney General Jeff Sessions, whose Department of Justice investigates and prosecutes fraud cases, said that he is confident that this 10% number is higher. “My experience over the years is that agencies, if anything, underestimate the losses because it is embarrassing to them.”4
Let’s assume that $60 billion in fraud is the right number. How does it compare to other agencies in the federal government where increased investments could potentially deliver significant returns? It is more than the combined budgets of National Institutes of Health (NIH) sponsored medical research ($33 billion), Pell College Grants ($22.5 billion) and EPA ($3 billion), or almost twice the combined budget of NASA and National Nuclear Security Administration.
Happily, the business of healthcare is very profitable. A recent McKinsey5 study showed that the healthcare industry’s profit pool for the years 2012 – 2016 as measured in EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) grew from $430 billion in 2012 to $516 billion in 2016, almost 16% of NHE. The growth rate of profit pool was 4.6%, more than twice the combined rate of the top 1000 companies (2.2%). By 2020, the profit pool is expected to be $620 to $670 billion range, maintaining or increasing as a percent of NHE.
It is no surprise that the U.S. healthcare system is one of the most expensive in the world. According to CMS, in 2016, on a per capita basis we spent $10,348 and healthcare was 17.9% of the Gross Domestic Product (GDP), which is almost 50% more than the next country among the rich economies as per the Organization for Economic Co-operation and Development (OECD). Yet the U.S. is one of the lowest in outcomes such as life expectancy, and declined in the last two years in a row.
In the similar vein, the Economist magazine in its recent issue6 tried to answer the question “where does, about $5000 more per person that the US spends on healthcare than other rich countries, go? As I pointed out above that the waste due to misuse, overuse and abuse of resources is a major part of it, however, the Economist focused on a “more controversial” area of excess spending which it called as the “rent-seeking by health-care firms”. It defined rent-seeking as “when companies extract outsize profits relative to the capital they deploy and risks they take”.
To understand “the scale of gouging and who is stiffing whom”, the Economist analyzed Bloomberg data of 200 American listed healthcare firms. As a group it accounted for a whopping $65 billion a year in “excess profit”.
So what are “excess profits”? The Economist defined them as “those earned above 10% return on capital (excluding goodwill), a yardstick of the maximum that should be possible in any perfectly competitive industry”. Contrary to the perception, the study found that the pharmaceuticals companies are not the worst offenders, but a slew of what it called as “corporate healthcare middlemen”.
These corporate middlemen occupy the multiple layers of the healthcare hierarchy such as insurance companies, pharmacy benefit managers, providers, pharmacies, wholesalers and drug and device manufacturers. The rebates flow back and forth, in multiple directions in this complex structure, making it difficult to figure out the real cost of product and services (net of rebates).
A hugely complex system made hugely opaque for making huge profits.
These $65 billion in excess profits represent only 4%, a tiny fraction of the healthcare overspending of about $1.6 trillion, but they are astonishing when compared to the profitability of other industries. For example the Economist study showed that these excess profits were equivalent to $200 per person per year, but dwarfed oligopolies – industries that are dominated by a few players with limited competition, such as airline industry ($25), telecom and cable TV industry ($69).
According to the Economist, the combined profits of relatively unknown three wholesalers in the industry would exceed that of Starbucks this year. The returns of the 46 middlemen have soared to 41% of the industry profits from just 20% in the last 15 years.
No wonder there is rush to create conglomerates that play in multiple layers of this “middle kingdom” of health care such as Cigna (insurance)/Express Script (benefit manager), Aetna (insurance)/CVS (pharmacy and benefit manager) mergers.
The state of healthcare today is an industry with unmanageable structure that causes huge waste, costing almost 18 cents on the only dollar we have and expected to grow faster than the GDP. The result is that the key segment players are building opacity in an already hugely complex structure and hiding behind it to make enormous profits, leading to increasing cost to consumers in the form of higher drug costs, increased premiums, larger deductibles, reduced choices and more expensive services, approaching $50,000 annually in GDP for a family of four in healthcare alone.
In the meantime, the system as a whole continues to decline, where the daunting issues of healthcare such as cost, overall population healthiness, life expectancy, quality and access are getting worse.
Clearly, the current state of healthcare is not sustainable.
So, why would ABJ Venture fail?
Simply speaking, by taking a myopic view. Given the size of the industry, its unbelievable complexity and enormous inefficiency, it is easy to be dazzled by the “potential for disruption” or reduce healthcare cost by “using leverage” or squeeze in as a middleman “using technology platform” or a combination of such “opportunities” and be “phenomenally successful” by the Wall Street standards and declare victory.
Such an effort may help save a few dollars for the combined million or so employees of Amazon, Berkshire and JP Morgan. But it would hardly make a dent in the overall 196 million (2016 estimate) market of the privately insured population and even less in the broader healthcare industry.
It would be a shame, a failure and a colossal waste of opportunity to not address the core challenge of healthcare.
The Core Challenge of Healthcare
The trillion-dollar question is: why major issues of healthcare such as cost, overall healthiness, quality, life expectancy and access are deteriorating?
Unfortunately, this critical question persists with ever increasing urgency, despite the sustained efforts, medical advancements and technological investments such as:
Dedicated improvement initiatives for decades by virtually every healthcare organization involving scores of highly committed professionals;
Innovations in such fields as medical science and technology, big data, advanced analytics, machine learning and digital technologies;
Investments in improving efficiency through targeted solutions backed by venture capitalists and smart money;
High profiled previous initiatives like ABJ Venture.
The answer is not necessarily better technology or greater advancements in medical science, or even better policy or politics, although all of those are clearly beneficial.
The answer lies in the enormous structural complexity of the healthcare industry as a business and its detrimental impact on the essential functions such as how it buys and delivers services; manufactures and distributes products; defines, measures, incentivizes and compensates performance.
It is a management problem that creates huge value leakages throughout the system. It has morphed into an unmanageable system that is prone to gaming and exploitation, causing unbridled cost escalations and excessive profiteering. It has resulted in an inequitable distribution of the benefits of medical advances and technological improvements while the system as a whole is getting worse quicker and in greater magnitude.
Clearly making tweaks or throwing technology at the existing structure have not worked and will not work, but worse, they may be further exacerbating the overall healthcare systemic issues.
So, how do we address this structural challenge that is at the core of the healthcare mess we are in?
In my next article, I’ll explore major drivers that are causing enormous structural complexity and making healthcare as the unmanageable “wild west”, minimizing and potentially negating the impact of current and future advancements and investments.
In my third article I would outline the potential solution, a model that could overcome the underlying issues and help transition to an unambiguous performance based system that is consumer centered, reduces overall costs, improves healthiness and enhances customer experience.
In my fourth article, I would share the results of a study involving 260,000 patients and demonstrate through data analyses the effectiveness of the model in creating a simplified system and its, potentially, transformative impact on the major stakeholders in health care.
- “Full Transcript: Interview with Warren Buffett”, CNBC Squawk Box, Monday February 26, 2018.
- “Shareholder Letter”, Dimon, J.P. Morgan, April 5, 2018.
- “National Health Expenditure 2016 Highlights”, Center for Medicare & Medicaid Services.
- “Fighting Back”, Page 12, AARP Bulletin, April 2018.
- “Future of healthcare”, Singhal, Latko, Martin. January 2018. McKinsey & Co. Healthcare Systems and Services.
- “Health care profits”, Page 66, Schumpeter, The Economist, March 17th – 23rd, 2018.
Jay Mathur is the founder and CEO of valueideas, a firm focused on solving complex management challenges. He has studied and addressed structural complexity and its impact across multiple companies in multiple industries. This series of articles are based on his insight and experience in working with multiple segments of the health care industry including employers, health plans, health systems, physicians, ancillary services, pharmaceuticals and device manufacturers.